Introduction to Income Tax and NICs Deductions
3.3.4 Pension schemes and contributions
Generally, a pension scheme can be categorised as either registered with or not registered with HMRC. If the scheme is registered, then amongst other things, the employee’s contributions are tax -deductible. Pension schemes that operate the Net Pay Arrangement require employers to send them contributions that already take the employees’ tax relief into account. This is done through the payroll by deducting contributions from gross pay before calculating the income tax due. Alternatively, pension scheme providers can claim the tax relief from HMRC directly, under an arrangement called Relief At Source (RAS). Contributions to schemes that operate RAS must be taken from earnings after income tax has been calculated. It is very important that the tax relief method operated by an organisation’s pension scheme (or schemes) is understood so that payroll can take contributions from earnings at the correct point. Note that the CIPP’s examples, exercises and exam questions use RAS (unless otherwise stated).
In addition, a pension scheme is generally either:
• A personal pension plan (individual pension, arranged without the employer’s involvement) • A Group Personal Pension (individual pensions collected together for administrative efficiency, where the employer facilitates access to the pension and usually contributes) • An occupational pension scheme (employer more involved in the design and governance of the pension scheme, together with trustees).
Finally, pension schemes can also be categorised as either:
• Defined benefit (DB), where the salary-related benefits at retirement are defined from the outset • Defined contribution (DC), where the contribution levels are defined but the benefits at retirement will depend on what the fund is able to purchase. The amount of the employee’s contributions to the pension scheme will be either prescribed in the scheme rules or decided by the member. Generally, occupational pension schemes specify the amount or rate of contribution to be made by the employee (and employer).
It is essential to note that:
• Not all pension schemes operated by employers are registered with HMRC
• Not all employee pension contributions reduce the gross pay for tax.
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